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Friday, April 10, 2015

On Contractionary Union Budget of 2015-16

Surajit
Das

In the first budget of the newly
elected NDA government, the total expenditure of the central government has
been restricted to 12.6% (a decline of 1.6 percentage points) of expected GDP
during 2015-16. For 2014-15, it was budgeted to be 14.2% of GDP by the previous
UPA government and as far as the actual spending by the present NDA government
is concerned, it is (revised) estimated to be 13.3% of GDP.What does this mean?
It simply means that the presence of central government in total national
income has already shrunk than what was budgeted during the last fiscal year
and it is being planned, according to the budget 2015-16, to bring it down further
in this financial year starting from April, 2015.

The official excuse for the
smaller government is that the centre is apparently being compelled to transfer
more resources this time to the States following the recommendations of the 14th
Finance Commission. True, the Finance Commission has recommended that 42% of
centre’s tax revenue has to be devolved to the States. As a result, the State’s
share in central taxes as percentage of GDP is expected to go up from 3% in
2014-15 (budget estimate) to 3.7% of GDP in 2015-16.However, the claim that the
centre’s fiscal space has shrunk because of larger transfer to States is a
claim, which is partially true because of the fact that the devolution has gone
up by 0.7 percentage points of GDP as compared to the decline in the centre’s
expenditure by 1.6 percentage points.How to explainthe 0.9 percentage points of
additional decline in the centre’s expenditure as proportion of GDP?

Well, firstly, the fiscal space
has been contracted by (estimated) decline in the estimated gross revenue
receipts of the central government (including States’ share) as percentage of
GDP from 12.5% in 2014-15 to 11.8% in 2015-16 i.e. 0.7 percentage points
reduction. Since, the estimated tax devolution to states is gone up by 0.7
percentage points in 2015-16, the centre’s net revenue receipts have come down
by 1.4 percentage points. Secondly, it is shrunk by 0.2 more percentage points
due to the reduction in the fiscal deficit from 4.1% in 2014-15 to 3.9% of GDP
in 2015-16. These two together curbed the fiscal space of the central
government by 1.6 percentage points of GDP in 2015-16.

The tax devolution has been
estimated to increase by Rs.1.4 lakh crore this year as compared to the budget
estimate of last year and the total central assistance for State & UT plans
is being cut down by Rs.1.3 lakh crore. The non-plan revenue grants to State
and U.T. governments is budgeted to go up by around Rs.0.4 lakh crore. However,
the total transfer of resources from centre to States (including the tax
devolution, assistance for State plans and non-plan revenue grants) as
percentage of GDP during 2015-16 has been estimated to be 5.9% as compared to
that being 6.2% during last year (See
Mitra 2015, www.macroscan.org).

Therefore, the states’ fiscal
space is not going to expand due to larger tax devolution simply because of the
fact that the total transfer of centre to states as proportion of GDP is actually
coming down. The centre’s expenditure is coming down by 1.6 percentage points.
As far as the combined government expenditure of centre and states are
concerned, clearly, it is likely to decline by more than 1.6 percentage points
provided states’ own tax revenue or states’ fiscal deficit do not go up as
percentage of GDP. If that is the case, then the excuse of ‘cooperative
federalism’ for reduction in central government expenditure as proportion of
GDP can’t stand logical scrutiny! From the states’ point of view, they receive
less transfer from the centre than before (as percentage of GDP) and, on top of
that, the centre reduces its own expenditure. As a result, the combined
expenditures of the central and the state governments would come down as
proportion of GDP in general.

The gross revenue receipts of the
Central government are estimated to come down mainly due to shortfall in tax
revenue. Centres’ gross tax revenue has been estimated to come down by 0.5
percentage points during 2015-16. This implies that the underlying assumption
about the tax buoyancy (elasticity: both because of change in the tax rates and
that in the tax base) of the central government must have been less than one
i.e. if the national income rises by 1%, the tax revenue would rise by less
than 1%.Even if the tax rates remain the same, without any extra tax effort and
efficiency on the part of the government, with increase in GDP, the gross tax
revenue is expected to increase at least proportionately. Assumption of less
than unitytax buoyancy simply means that the government is planning to cut down
either the tax rates or the tax effort or both. Therefore, the broad policy
direction of the present government is that there would be tax-cuts as
proportion of GDP and (due to reduction in the fiscal deficit to GDP ratio)
there would be expenditure cuts at a more than proportionate rate.

It is important to discuss the
current growth scenario of Indian economy to understand the specific context of
Indian economy in which this budget has been announced. According to the new
GDP series of Central Statistical Organisation (CSO), the growth rates (of GDP
at constant 2011-12 basic prices) for the years 2013-14 and 2014-15 have been
6.9% and 7.4% respectively. There are four components of GDP (from the demand
side)viz. private consumption, private
investment, government expenditure and net exports of goods and services. As
compared to 2012-13, the share of private and government consumption
expenditures (taken together) in GDP remained more or less the same during the
last two years. The investment (gross fixed capital formation) rate in the
economy,including government and private investment, has come down by more than
2 percentage points of GDP. The change in stocks (CIS) and valuables (taken
together) as proportion of GDP has also come down by more than 2 percentage
points. Therefore, the growth in the level of investment including change in
stocks and valuables must have been much less than the growth in GDP. As far as
the exports of goods and services are concerned, its share in GDP has come down
by 1.5 percentage points in 2014-15 due to poor export growth rate of less than
1%. What is then the source of 7% or more growthrate in the economy?

Apart from the private and
government final consumption expenditure, the other major contributor to 7% or
more growth is neither the private investment nor the investment by the
non-departmental government enterprises nor the export but it is interestingly
the reduction in the import. The import growth rates have been negative during
2013-14 and 2014-15 and its share in GDP has come down substantially from 31%
in 2012-13 to 24.6% in 2014-15. The import bill has come down mainly due to
reduction in international crude oil prices and also due to some checks in the gold
imports. Since, it is the net export (i.e. export minus import), which enters
into the GDP calculations, this reduction in imports have contributed
enormously in GDP growth of last two years through reduction in current account
deficits (from 6.4% of GDP in 2012-13 to 1.4% in 2014-15 at constant 2011-12
prices: see the table below).

CSO
Advanced Estimates of Components of GDP: New Series

Growth Rates

Share in GDP

2012-13

2013-14

2014-15

2012-13

2013-14

2014-15

pfce

5.5

6.2

7.1

pfce

57.9

57.5

57.3

gfce

1.7

8.2

10

gfce

10.8

10.9

11.2

gfcf

-0.3

3

4.1

gfcf

31.9

30.7

29.8

cis

-6.2

-21.4

3.9

cis

2.2

1.6

1.5

Valuables

3.3

-48.7

28.2

Valuables

2.8

1.4

1.6

Export

6.7

7.3

0.9

Export

24.6

24.7

23.2

Import

6

-8.4

-0.5

Import

31

26.6

24.6

Disc

Disc

0.8

-0.3

-0.1

GDP

5.1

6.9

7.4

gdp

100

100

100

Source: CSO Press Release
dated 9th February, 2015.

Notes: PFCE is private final
consumption expenditure, GFCE is government final consumption expenditure, GFCF
is gross fixed capital formation, CIS is change in stocks, Disc is
discrepancies and GDP is gross domestic product.

In the context of a demand
constrained economy characterised by large scale involuntary unemployment and
widespread unutilized capacity, the domestic private final consumption
expenditure in real terms cannot keep increasing unless the purchasing power increases
in the hands of the people. The real purchasing power (given the tax rates) would
not increase unless people earn more income in terms of wages, rents and other
factor incomes. Again, extra income cannot accrue unless the government spends
or the private investors invest.The private investors would not invest unless
their expected risk-adjusted rate of profit is higher than the cost of credit
and also unless they are confident that they would be able to sell their
products in the market in order to realise the profit. If people don’t have
enough purchasing power, then, in absence of enough export demands, the
investors would not invest due to lack of demand for their products in the
market.

One way to come out of this
vicious circle could be, as suggested by John Maynard Keynes in 1936 (in
General Theory of Employment, Interest and Money), by enhancing the government
expenditure without increasing the tax revenue or, in other words, by
increasing the fiscal deficit. If the government taxes more, then also the
aggregate demand comes down through reduction in disposable income of the
people. But, if the government increases its spending, it gives rise to an
increase in the aggregate demand through greater income and purchasing power of
people. Given the ongoing fiscal conservatism and rule based budgeting, we have
closed down that option, too. The international price of crude oil cannot fall
continuously every year, neither the gold import, for that matter, can
substantially fall every year over the previous year. The export demand is
largely exogenously determined in the sense that it depends,to a great extent,on
the demand from our major export destinations. Private investment demand is also
falling as proportion of GDP. In this particular macroeconomic context, the
union budget of 2015-16 proposes to cut down both the fiscal deficit as well as
the aggregate government expenditure as proportion of GDP.

In this budget, the underlying
assumption must have been that the larger fiscal deficit to GDP ratio would
necessarily cause crowding-out of private investment through rise in interest
rate and as a result of that, the private investment demand would come down
further. We all know that the RBI can always control the interest rate and
hence crowding-out is obviously not inevitable. If invested strategically, the
government investment may crowed-in a lot of private investments as well. But,
the capital expenditure (net of disinvestment receipts) is, in fact, budgeted
to come down this time as percentage of GDP. There is no plan to increase the
investment of public sector enterprises either (See Patnaik 2015, Peoples’ Democracy). Therefore, thegovernment is
entirely banking upon the private sector investment for growth and (given the
state of technology) for aggregate employment generation, the rate of which is
on the decline at the moment.

The government intends to boost
private investment rate by reducing the profit tax rate from 30% to 25% i.e. by
giving 5 percentage points tax incentive on corporate profit for next four
years. However, mere reduction in the profit tax rate alone would not be able
to excite the investors because of the following reasons. Firstly, as mentioned
above, the investors would not increase their level of investment unless they
are sure about enough demand for their products in the market. If they cannot
sell their products, the profit would not be realised at the first place and
the question of 5 percentage point tax incentive comes later.The investors
would not mind paying Rs.30 as tax if their realised profit be Rs.100 rather
than paying a tax at a rate of 25% when their profit squeezes to Rs.80 due to
lack of demand. In the previous case, the net profit after tax would be Rs.70
as compared to that of Rs.60 in the latter case.Moreover, if the effective
profit tax rate actually increases on an average, as has been claimed in the
budget, then the investment rate is likely to come down given any level of
profitability.

Presumably, the government
economists think that the reduction in profit tax rate would encourage more
saving out of profit, which in turn, gets reinvested. But, the investment
demand is not coming down because of lack of saving rather, it is coming down
because of lack of aggregate demand. The empirical proof is that the commercial
banks are holding around 30% of their liability (NDTL) worth of government
securities as compared to the SLR requirement of only 21.5%. If there is enough
demand for credit (by the ‘good borrowers’) in the market, the commercial banks
can easily meet the extra credit demand. If the aggregate income rises at a
slower rate, being a positive function of income, the aggregate saving would
also rise at a slower rate, given the distribution of income. If the income
distribution shifts in favour of the industrialists and against the wage
earners, then of course the aggregate saving rate would increase because
usually more proportion of profit and less proportion of wages are saved. Even
if the saving rate rises, there is no necessity that the investment rate would
also rise proportionately irrespective of the state of aggregate demand in the
economy.

If the private investment rate
does not go up automatically, in absence of an increase in public sector
investment, the rate of growth of output and employment would come down almost
certainly if the current account deficit does not keep improving continuously.
However, the current account deficit is, at the first place, beyond our control
and it is also unlikely that the current account deficit to GDP ratio would
continuously improve, which is already less than 1.5% of GDP. The government
expenditure to GDP ratio is also being planned to be brought down to continuewith
the ongoing neo-liberal agenda of fiscal conservativeness.

This budget would definitely have
a contractionary effect on the growth of aggregate level of activity and employment,
which would curb the average real purchasing power of common people further.
Alternatively, instead of cutting down the tax-GDP ratio and fiscal deficit to
GDP ratio and hence reducing both revenue and capital expenditure as proportion
of GDP in this budget, the central government could have increased the expenditure-GDP
ratio by increasing both tax-GDP ratio and the fiscal deficit to GDP ratio.
India has one of the lowest tax-GDP ratios in the world and also 1 or 2
percentage point increase in the fiscal deficit to GDP ratio would not have
caused any harm to the economy necessarily. Under a situation of reduced export
growth and falling investment rate, the need of the hour was an expansionary
fiscal stance rather than a demand contractionary fiscal policy in the context
of a demand constrained economy like India. However, the government is doing
just the opposite.

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